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Capturing and Protecting Extreme Profits


Over the last six months, the markets have continued to increase in their volatility and many of you wonder how to deal with this issue. There are several things you can do to work within this environment. This article is intended to direct you to actions if needed that are likely to be more structured, rather than actions based on anxiety or emotions. While many of these actions will help in certain windows of market activity of high volatility, only certain elements of the strategy should be applied in normal trending environments.

Overall, these strategies deployed over a long-term are likely to cause a decline in overall returns, rather than enhance them. However, for highly volatile stocks with beta of 2+ or stocks that have exceeded or are in runaway pattern, this strategy can be very helpful locking in profits.

The strategy can be used on a number of levels such as scaling out of the position or exiting a position altogether. It is my suggestion, should you deploy any of these ideas in this article, that you document them and go back to review what the outcome was.

For example, if you want to utilize the strategy to exit a position based on a short term pattern, utilize one of the daily models (use best optimize models for this strategy.) The two basic actions you could take is to exit the position completely or to sell half of the position on a daily exit signal and exit the balance of the trade when the weekly models issues an exit.

You must be aware that this will increase the ticket volume and therefore the cost of running a strategy. This is why I suggest that if you do deploy these ideas, that you deploy them on symbols that have exceeded their expectations both in returns or holding periods or a combination of both. Also, if there is news on a stock that causes the price to move up sharply, you can also deploy a daily model using the exit on half or all of the position, depending on the circumstances surrounding the symbol.

There are many elements that are necessary in utilizing VPM on individual equity strategies due to corporate actions, sharp movements in prices both up and down, stock splits, spinoffs, and other events that can affect the pricing of the stock that you own.

This is why I have suggested over the years that in any actions that you take, record them in your tracking manual. I strongly suggest that you maintain these as they will help you understand your actions and give you the ability to review them and validate these actions as you move forward.

While you could use outside tools to make these decisions, my suggestion is to utilize the VPM process. We have to tools available to identify the same patterns on shorter-term charts that were defined on the longer-term charts. This maintains consistency by using the same strategy to make all of your decisions.

An article that I wrote several months ago discussed how overrides and user intervention result in lower returns over 60% of the time when applied on an ongoing basis. But there are often times in the real world decisions that have to be made for a plethora of reasons when managing money.

There are windows in time that volatility is extreme, especially volatility in individual issues, that will require that these actions to be executed.

Many of you have wondered about the use of stop loss orders or other types of technical issues to control downside risk. This action is intended to protect a stock that you purchased or in the case of a stock that has run away to the upside and has exceeded your expectations from a return standpoint.

This basic strategy is useful more in individual equity strategies than it would be in mutual funds or indexes. Often times, there are symbols that you may purchase that will have very strong rallies and exceed the stats listed on the trade profile. This profile will display what the average holding period is and what the expectation for the returns are within a standard deviation of both holding periods and return expectations. Oftentimes, when stocks exceed these expectations, you get into a window of time that has more uncertainty.

I've never been a fan of stop loss orders. My experience is that often there are especially amateur type ideas where people will just say “I don't want to risk more than 10% from any entry point or a trailing stop from a recent high.” This is a randomly chosen point which has nothing to do with the patterns or the expectations for any particular symbol. There are plenty of valid techniques with which to determine stop loss orders. Yet, in most cases people tend to utilize stops in a more random entry then a structured entry. Most of the times, the random 10% retracement number will cause you to get out of trades long before they have completed. This is especially true when you're monitoring and trading intermediate trends as they unfold over weeks and months.

An example of a failure in this methodology is a stock that's run from 20 to 30. If you place a 10% stop on the last peak at 30 with $26 ¾, the stock drops $3.50 and then reverses and runs to 35, 40 or higher. Meanwhile, if you get stopped out you become a bystander, watching the stock move up while you are on the sidelines.

The biggest issue with this strategy is there usually is no way or structure to reenter the stock for the reversal. So the end result is you make some money but left most of the profits on table. It increases your probability of selling before the rally begins. You will notice that if you look at the trade profile on most stocks, you can come up with an average loss number. This will give you a better idea of what the average loss is on that model and some perspective on what usually occurs when there are losing trades on that particular symbol. 

The table below shows that average loss on an optimized symbol over the total database of 18333 symbols is 8.757 percent. This doesn’t mean this is the max, but overall the system has always done a good job at protecting the downside.

When I quote “Process Over Attitude and Opinion,” this does not mean that there are not valid processes that you can to apply to your portfolios to maintain stability as well as control risk. My suggestion is that if you're going to utilize some sort of shorter-term strategy wrapped around a VPM weekly signal, then I would use the daily model to determine when to modify a position that was issued by a weekly signal.

I am working on several articles that will be released over the next couple of months. These will help you understand and deploy a more dynamic overlay to properly maintain your strategies as you walk your screens forward along with other dynamic events in VPM.


Bob Kendall


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VPM Partners LLC

Sedona, AZ.

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For 20 years, our VPM portfolio management process has given thousands of advisors the ability to build and maintain quality and scalable strategies. Through integration with partnerships and dozens of prebuilt strategies, VPM and its consultants can guide you through the entire process in building a true scalable and deliverable product suite.

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